Investment Valuation in India

One of the methods of valuing a company based on Discounted Cash Flow Method is as follows: Value of the Company = Free Cash Flow for the Firm (FCFF) for next year / (Cost of Capital - Growth Rate) where: FCFF = EBIT next year x (1 - Tax Rate) x (1 - Reinvestment Rate) Cost of Capital is the Weighted Average Cost of Capital (WACC) i.e. Weight of Debt (Wd) x Cost of Debt (Kd) + Weight of Equity (We) x Cost of Equity (Ke) Reinvestment Rate represents the amount required to be invested in the company every year to keep the company looking good and working well, even if the company does not grow in size. Reinvestment Rate is calculated as Expected Growth rate (g) / Cost of Capital (Kc) Note this is a simplistic method of calculation and is just one of the many ways of calculating value of a company. The method assumes that the company is growing at a constant growth rate which may not be a fair assumption to make, especially in case of start-ups or companies underg...

A good financial modeler should also be aware that besides the most commonly used Discounted Cash Flow (DCF) approach and Market Multiples approach, there are a number of alternative financial valuation techniques that can be used to provide different viewpoints in a financial modeling and valuation exercise. Alternative valuation techniques, when used in combination with the DCF or Market Multiples approach, allow investors or business owners form a holistic view through multiple perspectives on the value of the business under consideration. Alternative valuation concepts include Asset Replacement Cost and Control Premium. Asset Replacement Cost Assessing the adjusted cost of replacing the useful assets of a business is a useful way of valuing capital intensive businesses such as those in the infrastructure and industrial related sectors. Control Premium The term “Control Premium” refers the the extra that typically must be paid to gain operating control of the business. An acquirer w...

We now begin the discussion of the discounted cash flows valuation model . Cash flows to equity are cash flows after debt payments and that cash flows to firm are cash flows before debt payments. When valuing a company using cash flows to firm, one needs to use the cost of capital when discounting the cash flows and then you need to subtract out debt . The most important part of this discussion is to pick an approach and stick with it. Don’t mix and match. I must admit that in the past I’ve gotten confused and probably mixed and match components of valuing stocks by discounting cash flows to equity and valuing stocks by discounting cash flows to firm. There are three main mistakes that you need to watch out for, which include: Discounting cash flows to equity at the cost of capital to get equity value Discounting cash flows to firm at cost of equity to get firm value Discounting cash flows to firm at cost of equity, forget to subtract out debt, and get too high a value for equity Make ...